Ethanol Going Ugly Turns Bush Plan Into Obama Test

U.S. ethanol production is headed for
the first decline in 16 years, jeopardizing the nation’s drive
to boost alternative fuels, as higher costs and lower demand
close plants.

Shrinking distilling margins have resulted in a 14 percent
drop in output this year to 827,000 barrels a day, or 12.7
billion gallons annually, Energy Department data show, 500
million gallons short of the amount refiners are mandated to use
under a 2007 law that calls for escalating consumption of the
biofuel. That would be the first yearly decrease since 1996.

As many as 10 companies, from Valero Energy Corp. (VLO) to
Biofuel Energy Corp. (BIOF), have closed distilleries after the worst
drought since the 1950s sent the price of corn to a record just
as gasoline demand slumped. President Barack Obama’s
administration has until Nov. 13 to decide whether to agree to
calls from a bipartisan group of lawmakers for the suspension of
the law, which was the centerpiece of George W. Bush’s plan to
wean the U.S. off oil. Ethanol accounts for about 9.2 percent of
total gasoline consumption, according to the Energy Department.

“It’s an ugly situation that continues to get worse,”
Jason Ward, an analyst at Northstar Commodity Investments LLC, a
Minneapolis-based risk management company that specializes in
agribusiness and renewable fuel, said in a telephone interview
on Oct. 26. “The margin simply isn’t enough to run full
capacity or in some cases even at all. You can lower the
standard but the market is going to take care of itself.”

Not Enough

Ethanol, made in the U.S. by fermenting starches from corn
to create an alcohol similar to moonshine, has gained 6.4
percent this year to $2.344 a gallon on the Chicago Board of
Trade, not enough to make distilling it profitable. Prices are
down 12 percent from a year ago.

Corn futures for delivery in December rose 3.25 cents, or
0.4 percent to $7.4425 a bushel in Chicago. Prices for the most-active corn contract rose to a record $8.49 a bushel on Aug. 10.

Based on December contracts for ethanol and corn, producers
are losing about 36 cents on each gallon of the biofuel made,
according to data compiled by Bloomberg. They were earning 24
cents a gallon a year ago. The numbers don’t include profit from
the sale of dried distillers’ grains, a byproduct of ethanol
production that can be fed to livestock.

“Right now, it is the toughest time ever to run an ethanol
plant,” said Bruce Babcock, an energy and farm economist at
Iowa State University in Ames. “It’s never been this bad in the
last four years.”

More than a dozen producers, including Brookings, South
Dakota-based VeraSun Energy Corp., once the largest American
distiller, filed for bankruptcy protection over an 18-month
period starting in October 2008.

Renewable Standard

The 2007 law enacted under President Bush, known as the
Renewable Fuels Standard, or RFS, requires refiners to mix 13.2
billion gallons of biofuels, such as ethanol, with gasoline in
2012 and 15 billion by 2015, a 67 percent increase from the 2008
target.

In its latest Short-Term Energy Outlook yesterday, the
Energy Department estimated that ethanol production will fall to
13 billion gallons next year, 5.6 percent below the 13.8 billion
consumption target.

The 2012 corn harvest in the U.S., the largest grower and
exporter, will total 10.706 billion bushels, the lowest in six
years, the Agriculture Department said Oct. 11, of which 42
percent will go toward ethanol. Last year farmers grew 12.358
billion bushels and 40 percent was used to make the biofuel.

Decision Time

Lawmakers, including the governors of Arkansas, North
Carolina, Maryland, Delaware and Georgia, and a bipartisan group
of legislators in both chambers of Congress asked the
Environmental Protection Agency, which governs the program, to
suspend the mandate because of the potential impact on food
prices with a smaller corn crop.

EPA Administrator Lisa Jackson has 90 days from the Aug. 13
date when Arkansas Governor Mike Beebe, a Democrat, filed the
waiver request, saying the drought is having a severe economic
impact on his state’s poultry and cattle sectors.

The threshold to suspend the program, evidence that it’s
causing economic harm, isn’t likely to be met and the Obama
administration may also be hesitant to cross farm-state
lawmakers in the Corn Belt, including Iowa, the nation’s largest
ethanol producer, in an election year, said Divya Reddy, an
analyst at Eurasia Group in Washington.

“It’s a constituency that’s in every party’s interest not
to antagonize,” Reddy said. “The political side makes it very
complicated.”

Rising Supply

The drop in output hasn’t been enough to draw down a supply
glut of the fuel, said Garret Toay, founder of Toay Commodity
Futures Group LLC in Clive, Iowa.

Stockpiles slumped 5.6 percent to 18.1 million barrels in
the week ended Nov. 2, 10 percent higher than a year earlier,
according to Energy Department data. Inventories reached a
record 22.7 million barrels in March.

“A lot of these smaller plants are under the gun,” Toay
said. “It’s going to be decision-making time on whether to keep
running or close shop. It’s going to be a pretty tough
environment.”

The situation is being exacerbated by imports from Brazil,
where ethanol is made mostly from sugarcane, said Mike Blackford, a consultant at INTL FCStone Group in Des Moines,
Iowa.

Imports in the week ended Nov. 2 averaged 60,000 barrels a
day, compared with none a year earlier, government data show.

Production Credits

Each gallon of ethanol is assigned a Renewable
Identification Number, or RIN, which helps the agency track
whether obligated parties, or refiners, are complying with the
blending rules.

There are about 2.5 billion excess RINS in the market,
created from overproduction the past two years. Refiners can use
the credits in lieu of blending a physical gallon, Geoff Cooper,
vice president of research and analysis at the Renewable Fuels
Association, a Washington-based trade organization, said in an
interview.

New Energy Corp. said this week that it stopped production
at its 28-year-old plant in South Bend, Indiana, because making
the additive has become unprofitable.

Valero, the biggest U.S. refiner by processing capacity and
the third-biggest ethanol producer, idled distilleries in
Albion, Nebraska, and Linden, Indiana, until it’s profitable for
the plants to make the fuel, Bill Day, a company spokesman based
in San Antonio, said in an Oct. 30 e-mail.

Three of the company’s distilleries are operating at
reduced rates until margins improve, Valero said last week on a
conference call with analysts and investors. Valero has capacity
to produce 1.2 billion gallons of ethanol at 10 plants.

Plant Closings

That followed Bunge-Ergon Vicksburg LLC’s announcement to
temporarily shutter its Mississippi ethanol mill by Nov. 30.
Biofuel Energy, a U.S. producer of the additive partially owned
by venture capitalists David Einhorn and Daniel Loeb, said in
September that it closed its operation in Fairmont, Minnesota.

Southwest Georgia Ethanol LLC shut its mill in Camilla,
Georgia, possibly until next year’s corn harvest if necessary,
the company said Oct. 24.

Abengoa SA (ABG/P), a Spanish engineering and renewable energy
company, resumed output at its Madison, Illinois, ethanol mill
after temporarily idling it in October for maintenance and
because of poor margins.

“They’re going to run until they can’t or the banks say
otherwise,” Toay said. “Eventually it will cure itself. You
slow down ethanol production so much that it rations supply.”